Young buyers embrace cash over credit

By Rachel Sapin

Tuesday, August 27, 2013

When Stephen Miles Till and Daniel Evan Garza started A Small Print Shop out of Till's garage in 2010, the two bonded over their distrust of borrowed money. "We're a cash business," said 32-year-old Till as the two owners sat outside of the shop's shared industrial space on 28th and Larimer streets. "We like looking in the bank account and knowing that money is real," added Garza, 25.

Garza and Till are part of a growing number of people in their 20s and early 30s, who have eschewed credit cards for cash and debit cards in their personal and professional lives.

Data from the FICO Banking Analytics blog shows credit-card use has declined for consumers in all age groups since 2005, but the increase in the percent of consumers with no credit cards has been most dramatic for those ages 18-29. A recent Pew study of government data found that in 2010, only 39 percent of younger households (those under 35) carried a credit-card balance compared to 48 percent in 2007. The median outstanding amount owed among younger households with balances also dropped from $2,100 in 2007 to $1,700 in 2010.

Another post from FICO data scientist Frederic Huynh on credit trends by age also shows a bump in the percentage of people age 18-29 achieving higher credit scores by carrying less debt.

Huynh and other experts say the trend in younger consumers forgoing credit cards is a result of reforms in the industry through the 2009 CARD Act (such as disclosures of relationships between universities and credit-card companies, as well as bans on gifts like free T-shirts in exchange for applying for credit cards at university-sponsored events), a weak economy, larger student loans to pay off, and stricter lenders.

Till explains that when his print shop added three more employees and an automatic press to increase production, it was difficult to qualify for even a minimum $10,000 line of credit from the bank, given his limited credit history. "When I applied for a credit card to run the business too, they gave me a whopping $2,500 limit," he said.

Maclyn Clouse, a professor of finance at the University of Denver's Daniels College of Business, says debit cards are a challenge for credit scores as they do not report to the major credit bureaus. "A debit card is purely a transactional instrument," said Clouse. "That's not establishing a credit history for you. The only way you're going to get that good credit history is by having a real loan."

Instead of a credit card, Till was able to build credit with a mortgage on his house, which allowed him to underwrite and slowly expand the business. While this worked for him, home ownership has become less common for people his age.

According to the same Pew Survey, young adults have decreased their debt primarily by owning fewer homes and cars. Among adult households 35 and younger, the homeownership rate fell from 38 percent in 2001 to 34 percent in 2011, a greater decline than homeownership for individuals 35 and older.

Anthony Sprauve, a spokesman for myFICO.com, the company that develops the credit-scoring model used by each of the three major credit bureaus, explained it this way via e-mail: "Someone without a credit card, but an auto loan, personal line of credit or mortgage, would be able to get a good FICO Score." But a FICO news release from October 2012 also says that in some cases, using credit cards for occasional purchases "may be slightly better than not using credit cards at all."

Payment history makes up the largest portion of the FICO score at 35 percent, followed by amounts owed, which means credit cards with low balances (below 30 percent) factor positively into the score.

Todd Huettner, president of a residential and commercial real estate firm in Denver specializing in complex transactions, explains that not using credit cards won't necessarily negatively affect an individual's credit score and the ability to qualify for larger loans later on, but it could prevent someone from getting a higher score. "Revolving debt helps you and hurts you the most," he said. "That's why it's the hardest to manage. It requires the most responsibility."

And, Huettner says, lenders want to see who will provide the least risk, measured by a borrower's ability to handle different types of loans responsibly.

Huettner sees the industry responding to "underbanked" consumers by offering credit-building options beyond a standard credit card. "We've seen a proliferation of secured credit cards in the last couple of years," he said. Credit bureaus have also experimented with incorporating alternative data such as rent payments into custom scoring models, but the most widespread models like FICO continue to rely on traditional lines of credit.

For those who could use a credit boost, Huettner advises using a credit card only for special occasions. "You have a credit card you're using once a year so it keeps activity," he said. "It will help your credit score, but ... you're paying it off, and it's not changing your spending habits."

Credit scores don't seem to intimidate Garza and Till, who plan to expand their business on as little borrowed money as possible. They waited a year before buying their new automatic press.

"We had an opportunity take out a loan, and it didn't feel right," said Garza. "Finally, everything lined up, and we got a really good deal, and a really good connection for a personal investor."

The good thing about credit scores: They're fluid. The bad thing: They're fluid. Many factors can make a credit score go up one month and down the next. Luckily, all three of the major credit bureaus have pretty much the same advice when it comes to what consumers can do to build and maintain a consistently high score.

Check your credit report. Consumers are allowed one free credit report each year through Annualcreditreport.com. You can see what's reporting to the three major bureaus and check for errors that may be hurting your score. If you see errors, contact the credit-reporting company and the information provider. All three bureaus also have free trials where you can view your score in-depth.

Consider taking out a credit-builder loan or a secured credit card if you have little or no credit history. Length of credit history is 15 percent of your score. Local credit unions offer credit-builder loans and secured credit cards for individuals with no credit or those looking to improve their credit. You provide the collateral for both types of accounts and build a positive credit history when you pay them off each month.

Pay your bills on time. Payment history is the biggest factor affecting your credit and accounts for 35 percent of your score. Delinquent payments have a major negative impact on your score and stay on your credit report for seven years.

Keep credit-card balances low. Amounts owed account for 30 percent of your credit score. The magic number for credit cards is keeping the balance somewhere under 30 percent of the total limit.

Apply for new credit in moderation. New credit makes up 10 percent of your credit score. Opening multiple new accounts as well as having a number of new recent credit inquiries can negatively affect your score.

Maintain a healthy mix of credit. Types of credit used is 10 percent of your score. Credit histories containing a mix of revolving credit (credit cards, secured credit cards, lines of credit) and installment loans (mortgages, student loans, car loans, credit-builder loans) are considered healthier by lenders than credit histories with only one type of loan.

Make sure positive alternative data is reporting. You can now pay rent through WilliamPaid.com, which reports those monthly payments to Experian for free and builds your credit history if you pay online with a bank account.